Low Oil Prices Hurting U.S. Shale Operations

Yves here. In yesterday’s Water Cooler, Lambert posted a link from Bloomberg that indicated that oil at $80 a barrel would pop the fracking bubble, an outcome we’d discussed previously. Some readers in comments expressed doubts.

In fact, it was already happening as oil prices were falling from over $100 a barrel through the nineties. Seasoned energy hands had warned that shale operations could be shut down rapidly, and that has started to take place. However, the author of this article argues that the shutdowns are likely to be delayed and that most US shale operations have low break-even costs, insulating them from the impact of the oil price drop. However, he misses that another driver of the shale boom has been access to super-cheap credit and an overly-bullish mentality that has not factored in the short production lives of shale wells. The junk bond market has been much less accommodating of late, and if that skittishness continues, the prognosis isn’t quite as sanguine for the industry as Cunningham suggests.

By Nick Cunningham, a Washington DC-based writer on energy and environmental issues. You can follow him on Twitter at @nickcunningham1. Originally published at OilPrice

Slumping oil prices are putting pressure on U.S. drillers.

The number of active rigs drilling for oil and gas fell by their most in two months, according to the latest data from oil services firm Baker Hughes. There were 19 oil rigs that were removed from operation as of Oct. 17, compared to the prior week. There are now 1,590 active oil rigs, the lowest level in six weeks.

“Unless there’s a significant reversal in oil prices, we’re going to see continued declines in the rig count, especially those drilling for oil,” James Williams, president of WTRG Economics, told Fuel Fix in an interview. “We could easily see the oil rig count down 100 by the end of the year, or more.”

Baker Hughes CEO Martin Craighead predicted that U.S. drilling companies could begin to seriously start removing rigs from operation if prices drop to around $75 per barrel. Some of the more expensive shale regions will not be profitable at current prices. For example, the pricey Tuscaloosa shale in Louisiana breaks even at about $92 per barrel.

But that also reflects the high costs of starting up a nascent shale region.

Much of the shale basins that are principally responsible for America’s oil production will not feel the effects of low prices as quickly as many are predicting.

Better-known shale formations, such as the Eagle Ford in South Texas, can break even at much lower prices. That’s because exploration companies have become familiar with the geology and fine-tuned drilling techniques to specific areas.

Productivity gains have allowed drillers to extract more oil for each rig it has in operation. For example, in North Dakota’s prolific Bakken formation, an average rig is producing over 530 barrels per day from a new well in October. Less than two years ago, that figure sat at around 300 barrels per day. Extracting more barrels from the same operation improves the economics of drilling, which means shale producers are not as vulnerable to lower prices as they used to be.

Another factor that could insulate U.S. oil production is that companies also factor in sunk costs. That is, if they have already poured in millions of dollars into purchasing land leases and securing permits, throwing in a little extra money to drill the prospect is probably the rational thing to do even at current prices. It is only projects in their infancy that may not be economically feasible.

This should delay the drop in rig count, and delay the drop in overall U.S. oil production. As the Wall Street Journal notes, given these assumptions, U.S. oil production in the Eagle Ford, Bakken, and Permian could actually break even at just $60 per barrel.

Much rides on the decision making of officials in Saudi Arabia. Although exact calculations vary, the world’s only swing producer needs oil prices between $83 and $93 per barrel for its budget to break even. But that may not be as important of a metric as it appears. Saudi Arabia has an enormous stash of foreign exchange, and could run deficits for quite a while without too many problems. With average costs of oil production from wells in the Middle East sitting at only $25 per barrel, the Saudis can clearly wait out U.S. shale if they really want to.

But it may actually be Canada’s oil sands that end up being the first victim, the Wall Street Journal reports. Mining, processing, and pumping heavy oil sands from remote positions in Canada are much more costly than conventional oil and even shale oil in the U.S. While short-term operating costs are only around $40 per barrel, new projects need prices well above $90 per barrel to be in the money.

Rig counts are starting to drop, but due to the long lead time for most oil projects, it could be a while before production begins to decline in a significant way. What happens next will be largely determined by the outcome of the next OPEC meeting in Vienna on Nov. 27, where all eyes will be on Saudi Arabia.

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24 comments

  1. John

    The alarmist headline should read: Low Oil Prices Helping US Consumers Save Money.

    Using the word Hurting in American parlance conveys – this needs to be saved from its pain. Do something. Do anything to reverse course. Lend support.

    Everytime oil takes a precipitous dive panic sets in the American psyche. Where does this unneeded hysteria come from? Petroleum price drops elsewhere is shrugged off and welcomed as good news.

    To recap: Low cost, relative clean energy is good for the economy.

    1. Yves Smith Post author

      You miss that your spending is someone else’s income. The US is now an energy exporter. One investor tells me that all the growth in the US has been concentrated in states that participated in the energy boom. That is now going away. What is good for you may not be good for the economy generally, and that may come back to bite you later., particularly since this fall in energy prices is part of a general deflationary pattern.

      Now admittedly, the shale bubble was going to bust under its own weight at some point, but that is different than a more generalized pullback across energy producers.

      And this hurts solar and other alternative energy producers by reducing the attractiveness of switching to cleaner technologies.

      1. cnchal

        You miss that your spending is someone else’s income.

        For the huge majority, the dollars not spent due to lower oil prices is spent elsewhere, providing an income for someone not working in the oil patch, from which they can then spend.

        I have to agree with John, with one change. Low Oil Prices Helping US Customers Save Money so it can be spent elsewhere.

        1. Yves Smith Post author

          If you care about the future of this planet, you’d want higher energy prices all day. They force conservation, which is our only hope of getting carbon levels under control. The Saudis are signing our collective death warrant, but you don’t care because you get to spend more at the mall and the real consequences don’t start kicking in until 2030 or 2040, which is too far in the future for you to worry about.

          1. impermanence

            I would like to suggest that whatever we humans do will have zero net effect as far as the planet is concerned. When we are long gone, it will still be the insects and the weeds battling it out [as was the case before we showed up].

          2. CG

            The consequences have already started to kick in, no one will have to wait 15-20 years for the serious knock-ons. Gaming the pricing makes planning difficult, but if future energy supply information was reliable more of us would realize how inadequate our possible responses are.

          3. cnchal

            Higher energy prices did change North Dakota, and here is a description.

            Now, six years later, the region displays all the classic contemporary markers of hell: toxic flames that burn around the clock; ink-black smoke billowing from 18-wheelers; intermittent explosions caused by lightning striking the super-conductive wastewater tanks that hydraulic fracturing makes a necessity

            Perhaps if the Saudis had done this a decade ago, all this would have been avoided. Those steel pipes that get drilled in the ground? They rot and eventually the water will be crapified with the secret sauce they are injecting into the ground. 2030 to 2040 sounds about right too.

            NYC style housing costs out in the middle of North Dakota. Absurd?

            The Saudis are signing our collective death warrant

            The Saudis are in a tight spot. They want to maximize the wealth of their stash of oil. Is it best for them if they sell it cheap and burn as much as they can or stretch the stash by upping the price?

            Upping the price to $100 per barrel has brought out more ingenuity, and more production.

            This spring, production in North Dakota surged past one million barrels of oil a day. The source of this liquid gold, as it is locally known, is the Bakken Shale: a layered, energy-rich rock formation that stretches across western North Dakota, the corner of Montana, and into Canada. It had been considered inaccessible until breakthroughs in drilling and hydraulic fracturing made the extraction of oil from it economically feasible. In 2008, the United States Geological Survey (USGS) announced that the Bakken Shale contained 25 times more recoverable oil than previously thought, sparking the biggest oil rush in state history.

            It wouldn’t surprise me if upping the price to $200 per barrel brings on even more ingenuity and production, with evermore pollution and spoilage.

            Forcing conservation is a political decision. If you want it to be economic, pay people to not consume, much like some farmers get paid to not grow something.

            Speaking of the mall, how does the stuff get there? Doesn’t it come from China, mostly? All the energy in digging up minerals and shipping it to China, where it is manufactured into products and then transported back all over the world, to the mall, or an Amazon warehouse. China is a toxic waste dump as a result, doing energy conservation things like building cities capable of housing millions of people, with no one living there, in a box that rots style. Lucky to make it to 2020, never mind 2030. Because globalization.

            1. Lambert Strether

              “[T]he region displays all the classic contemporary markers of hell.” Yes, that’s why oil should be treated as a taboo substance, an object of fear and ritual disgust, and left in the ground.

    2. Aaron Layman

      You also apparently miss the link to wage growth that the boom has provided. Without the resurgent energy sector the anemic employment and wage gains we have experienced in the US would be even weaker.

      Regarding Cunningham’s piece, I wonder if he even bothered digging through the historical data available on Baker Hughes’ site. I’m assuming not, because he wouldn’t have made that statement about the Eagle Ford. Take a look at the data and see for yourself. Eagle Ford rig count has been declining all year. Well counts have also turned negative there.

      Cunningham is delusional if he thinks those prime basins can all break even $60 oil. I grew up in the Permian Basin. Just visited there a few weeks ago. What is happening in that area is not a miracle. It’s the side effect of flawed monetary policy and some blind luck. As someone who grew up during the 80’s boom and bust, it reminds me that we has humans are destined to repeat the mistakes of history, particularly when we place a higher priority on short-term profits rather than sustainable economic investment.

      1. Brent Shawalter

        All booms provide wage growth, but this one isn’t making the dent. The point is, high oil prices boost exploration and thus booms.

        You underestimate areas that need lower oil prices because of the lack of conversion to a new paradym. That drains more economic activity than gives it. Real prices have not dropped much. They are at the end margin price, though there I agree in the low-mid 80’s. If they fall below 80 toward 70 they will have to slow production.

    3. Jesse

      These are not low prices, we’re still above the “oil shock” prices of the 70’s. Otherwise, good point.

      1. Nathanael

        Thank goodness. There’s no way oil will ever be cheaper than solar power again.

        Oil is basically isolated to transportation fuel already. The breakeven for electrifying our rail network is already here, but the Class I railroad execs are overly conservative about capital spending. The major bottleneck on electrifying autos is now batteries. An electric car saves 4.6 cents per mile over a Prius at current gas prices in the US. You’d currently have to drive too many million miles to make back the difference in upfront costs between a cheap Prius and a Tesla, thanks to battery costs, but that’ll change.

    4. wbgonne

      “To recap: Low cost, relative clean energy is good for the economy.”

      No one can disagree with that proposition. However, it masks a couple dubious propositions. First, fracking is only “[l]ow cost, relative clean energy” when one ignores all the externalities (which is precisely the case today, unfortunately). Second, while being “good for the economy” is nice, human beings and our shared habitat are more important than “the economy,” which in the end is merely a social construct designed to serve society by organizing power. Placing the strength of “the economy” above the health of the habitat and the welfare of the people is a perversion.

      1. McMike

        And, under Jevons Paradox, lower cost fossil fuels means we will consume more fossil fuels.

        “Relatively clean” when it comes to fossil fuels is a lot like being a little bit pregnant.

  2. rjs

    chirstmas 2008 i talked to the vice president in charge of exploitation for Devon Energy; he told me he had no budget for exploration for the coming year with oil under $80…his team of petrogeologists would not be laid off, but they would spend the next year in the office gazing at their navels..

  3. wbgonne

    To the larger picture, there is little doubt that fracking will slow as oil prices drop. But that begs the question: what happens when oil prices go back up? Unless the interim is used to mount a serious challenge to fracking generally, it will surely resume once the pricing adjusts. The inhibitions on fracking could come from public opinion or government regulation or litigation (or a combination). But unless meaningful constraints are imposed fracking will simply take a hiatus to shelter the price-drop and then pick right up afterwards. I guess what I am saying is that I don’t think we can count on Mr. Market to save us from the scourge of fracking. I hope I am wrong.

  4. Chris

    Let’s not forget that fracking is an environmental abomination. Billions of gallons of water wasted and contaminated, tons of sand, concrete and steel needed to drill and get to these hard to reach deposits.

    And I haven’t even mentioned tar sands, which makes fracking look environmentally responsible by comparison.

    So I say good riddance, let’s hope crude continues to crater and all these ponzi drillers go bankrupt.

  5. McMike

    I am curious what this means for fracked gas.

    When gas dropped, the drillers just moved their rigs and bubble money over to oil. Now where do they go?

    The insiders I talk to say that they will lie low for a couple years, consolidate a bit, and bide their time until the export terminals come on line… then watch for all hell to break loose.

    Obama admin of course has fast tracked the export terminals.

    So much for all those assertions that domestic gas was about national security and clean bridge fuels. All that gas we have will go across the oceans in a generation, and then be gone up a smokestack just like that.

    And we’ll be left with a bazillion gallons of contaminated water on the surface, deep underground, and everywhere in between.

    1. James

      So much for all those assertions that domestic gas was about national security and clean bridge fuels. All that gas we have will go across the oceans in a generation, and then be gone up a smokestack just like that.
      And we’ll be left with a bazillion gallons of contaminated water on the surface, deep underground, and everywhere in between.

      I, for one at least, have confidence that events will intervene before most of that happens. The industrial economy the world over has been sputtering seriously of late and I’m not sure we’ve got the financial and other resources left to make that transition. We’ll see soon enough. The only thing that looks even vaguely like a growth industry these days is “defense”, aka the GWOT. And I imagine we’ve got more than enough weapons on hand to keep that one going for another few years at least.

      1. McMike

        I think that wall street, big oil, not as big oil, the defense establishment, the state department, the cia, halliburton, and the president all agree that they want to frack the living hell out of this nation while they can.

        And so they will.

        1. Nathanael

          People get kind of huffy about clean water. And the gas fracking operations were mostly frauds from day one; it’s *never* been profitable, so they’ve been land-flipping and scamming the big oil companies. They’ve alienated some people due to that…

          I think that is going to make it harder for the frackers to make a comeback.

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